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Regulation: Shadow banks slip through the net

Global regulators are pumping out new rules to address potential systemic risk within the shadow banking system, with money-market funds and repo in the firing line. While governments and central banks continue to offer underhand guarantees to non-bank credit intermediation, however, the moral hazard associated with the shadow sector is unlikely to go away.

Although it is generally agreed that the term shadow banking refers to the credit intermediation that happens outside of the regulated banking sector, global regulators have only recently emerged from a two-year effort to get to grips with what that means in practice and why it is of concern. Towards that goal, a lot of brainpower has gone into understanding the distinction between non-bank entities and their activities, and how a regulatory focus on the former might incentivize banks to outsource the latter to entities beyond the macro-prudential perimeter.

Now the debate is moving on from theory to implementation. Tasked with getting to the bottom of this problem by the G20 in 2010, the Financial Stability Board’s latest guidance on shadow banking acknowledges the protean nature of the non-bank sector and sets out an inclusive scheme of risk factors – maturity transformation, liquidity transformation, credit transformation and leverage – and the activities that might contribute to them, irrespective of the legal form of the entities involved.

The FSB defines those activities as the management of investment funds that are susceptible to runs, loan provision dependent on short-term markets, intermediation dependent on short-term or secured funding using client assets, credit creation, and securitization-based intermediation and funding activities.

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